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What is Overdraft Facility in Bank Accounts?

An overdraft facility in bank accounts is a financial arrangement provided by banks that allows account holders to withdraw funds exceeding the available balance in their accounts up to a specified limit. Essentially, it provides a short-term line of credit to cover temporary cash flow shortages or unexpected expenses.
When an account holder makes a transaction that exceeds their available balance, instead of rejecting the transaction, the bank covers the shortfall by extending credit through the overdraft facility. This allows the account holder to complete the transaction without incurring insufficient funds fees or having the transaction declined.
Overdraft facilities typically come with associated fees, including interest charges on the overdraft amount and/or a flat fee for each overdraft occurrence. Additionally, banks may impose a limit on the amount of overdraft allowed, which is predetermined based on factors such as the account holder’s creditworthiness and banking relationship.
Overdraft facilities can be useful for managing occasional cash flow challenges or covering unexpected expenses. However, it’s important for account holders to use overdrafts responsibly and avoid relying on them as a long-term solution for financial needs, as excessive use of overdrafts can lead to high fees and potential debt accumulation.

Features of Overdraft Facility

  • An overdraft facility in bank accounts is like a pre-approved loan. The bank ascertains a specific limit up to which you can overdraw on your account balance. You can withdraw that amount as and when required.
  • The approved limit and the overdraft facility interest rate are determined depending on your typical account balance, financial stability, nature of the collateral, etc.
  • The bank charges interest only on the amount used by you and only for the time it is borrowed. It is calculated daily and billed to you every month.
  • While the overdraft facility interest rate is predetermined, it may increase if you default on paying back the amount due.
  • You can pay back the amount as and when you have the funds, as a lump sum or in part payment, and there is no prepayment penalty or EMI concept like in loans.
  • While there is no minimum monthly repayment, you should pay it back when you have the money because it does affect your credit score.

Types of Overdraft Accounts

Similar to loans, there are secured and unsecured overdraft facilities. It means that if you opt for a secured overdraft account, you will have to provide collateral for the same. There are a few different collaterals you can provide.

They are as follows:

Overdraft against Salary

Overdraft facility for salaried individuals is available against your monthly income. Depending on the bank, you may be approved for a limit of about two times your salary. However, to avail of this facility, you need to have a salary account with the same bank.

Overdraft against House or Property

You can pledge your property to start an overdraft account with your bank. Even if you currently have a home loan that you’re paying back, you’ll still be eligible after a thorough check by the bank.

Typically, banks allow for the overdraft limit to be around 50% of the property’s value.

Overdraft against Fixed Deposits

Fixed deposits work as a better collateral alternative than housing property if you don’t need a high limit. The process is quicker, and the documentation is minimal.

Another plus to this option is that if you have a fixed deposit with the same bank, you’re applying for an overdraft account to, the process will be further expedited. The interest rate is also lower, and the limit sanctioned can be as high as 75% of your fixed deposit.

Overdraft against Insurance Policies

Another great collateral option for an overdraft facility is any insurance policies that you hold. The important factor here is the surrender value of your policy – it is the amount the insurance company will pay you if you decide to terminate the policy before maturity.

Overdraft against Equity Investments

It should be a last resort, as equity investments are the least preferred collateral for an overdraft account. Since equities are subject to market fluctuations, the limit sanctioned for the overdraft facility will be on the lower end.

Bank Accounts Eligible for Overdraft Facility

Initially, current accounts meant for business transactions were offered the overdraft account facility. However, now most bank account holders can avail of this facility irrespective of the type of bank account they hold. Overdraft facility is available to:

  • Current account holders
  • Salary account holders
  • Savings account holders
  • Deposit account holders